Breakingviews - RBS is a step away from ending its lost decade

A Royal Bank of Scotland branch is seen, in central London February 21, 2009. Royal Bank of Scotland Plc is set to unveil up to 20,000 job losses next week as part of tough cost-cutting targets, the Financial Times reported on Saturday. REUTERS/Luke MacGregor (BRITAIN) - LM1E52L15JT01

LONDON (Reuters Breakingviews) - The parable of the prodigal son tells the story of a young wastrel who squanders his inheritance only to beg forgiveness from a beneficent father. Royal Bank of Scotland is no stranger to contrite shareholder grovelling having delivered persistent losses since the financial crisis. The state-controlled lender’s first net profit in a decade brings deliverance – in the form of dividend payments – tantalisingly near.

Central to RBS’s rebirth has been the tricky balancing act of slashing costs while keeping revenue broadly stable. By this measure 2017 was an impressive year: revenue increased by 4 percent even as underlying costs dropped by 10 percent to 7.6 billion pounds. Chief Executive Ross McEwan has now delivered total savings of 1.8 billion pounds a year since 2015.

RBS will have to continue that act if it is to hit McEwan’s target for a 12 percent return on tangible equity by 2020. That feat is made trickier by the lender’s decision to abandon its 6.4 billion pound operating cost target for the same year. RBS now just says its cost-to-income ratio will be less than 50 percent.

Assume 2020 operating expenses come in closer to 7 billion pounds. In that scenario, RBS would need to expand revenue by 10 percent over the next three years to around 14.4 billion pounds to meet its return target, according to a Breakingviews calculation which assumes bad debt charges rise to 1 billion pounds a year in 2020 and earnings are taxed at 30 percent.

Then there’s dividends. Even after a 4.5 percent drop on Friday morning, RBS shares are up about 8 percent over the past year. That’s largely because the bank has about 6 billion pounds of capital more than it needs to meet its target common equity Tier 1 capital ratio of 13 percent. This could eventually be returned to shareholders via special payouts or a share buyback.

U.S. regulators may yet have other ideas, though. RBS has set aside $4.4 billion for fines relating to misselling pre-crisis mortgage-backed securities. However, analysts guess the shortfall could be anything between $1 billion and $9 billion. The worst-case scenario would wipe out RBS’s capital surplus.

McEwan may have ended the bank’s lost decade, but final salvation is still a step away.

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